401(k)s versus Social Security: Comparing the Rates of Return

A common claim of advocates of Social Security privatization is that private accounts deliver much higher rates of return for participants. The Cato Institute, for example, in its Cato Handbook for Policymakers tells us that:

�Social Security taxes are already so high, relative to benefits, that Social Security has quite simply become a bad deal for younger workers, providing a low, below-market rate of return. This poor rate of return means that many young workers� retirement benefits are far lower than if they had been able to invest those funds privately. However, a system of individual accounts, based on private capital investment, would provide most workers with significantly higher returns. Those higher returns would translate into higher retirement benefits, leading to a more secure retirement for millions of seniors.�

But is that true? To test the claim I compared my Social Security statement with my TIAA-CREF statement for a 401(a) plan which is essentially the same as a 401(k). Both list the total contributions made by the employers and myself. The Social Security statement indicates my benefit at 66, the age of my full retirement. My TIAA-CREF statement has the total accumulation. Since I am nearly 66 I can know much an annuity income it is worth.

My first year Social Security benefit was 12.61 percent of my total contributions. The first year TIAA annuity was 12.06 of total contributions�lower not higher than the return on my Social Security contributions as the Cato Institute so confidently claims.

It is important to point out so that as a professional employee, I am in a relatively high income category with a Social Security rate of return that is less than that of lower-income participants. For them, the rate of return for Social Security compared to private accounts would be much higher than mine, making it an even better deal.

Like the optimistic projections of the financial services industry whose interests it serves, the Cato Institute�s claim is based on before-the-fact overly optimistic assumptions of future market returns. My comparison was based on after-the-fact actual experience.

Addendum: from a reader of Social Insecurity: 401(k)s and the Retirement Crisis who ran his own numbers:

“I looked at my last Social Security statement that was mailed to me, which covered the years
from 1967 to 2011.  The contributions of my employers and my own added up to $115,000.
From then to retirement, another $8,000.  Thus a total o $123,000 gives me a retirement
income of just over $1800/month.
“For a 401K to achieve this at a 5% rate, I would need to save an amount of $432,000.  That is
being generous with the rate;  I think they are now around 4%.
“The above reminds me of a quote you included from Lawrence Summers.  To paraphrase,
its all about efficiency-99% of contributions go to benefits.”

–James W. Russell

Unfunded Liabilities of Public Pensions, A Red Herring

Rarely have so many people believed as an article of faith something so fervently that wasn�t true: unfunded liabilities of public pensions are speeding us toward fiscal Armageddon. Unless something drastic is done very soon, we taxpayers will have to bailout overly generous, fiscally irresponsible public employee pension systems. A class war is looming, according to one New York Times columnist, between taxpayers and the beneficiaries of these systems.

But ask most people who believe this what an unfunded liability is and they�re not exactly sure. They only know that it is bad, very bad, and threatening to them.

To understand what an unfunded liability is, it is necessary to look at how most pensions used to be funded, on pay-as-you-go bases. That meant that as contributions from employers and employees came in, they were paid out to retirees. It worked for government pension funds because you could assume that they would always be around with workforces to make contributions, unless one believed in the arch libertarian fantasy of total privatization, a government without government employees.

Without going to those extremes, one could reasonably believe that one day there might be fewer employees supporting more retirees and the fiscal balance would be upset. That possibility plus the reality that private corporations with pension funds might go bankrupt stimulated the call for prefunding of pensions. With a fully pay-as-you-go system, if contributions stop, as when a company goes out of business, pension payments have to stop too and current workers receive nothing for their contributions.

The whole idea of prefunding is to build up enough of a reserve in pension funds so that should contributions stop, there will be enough to keep paying pensions for the rest of retirees� lives and pay off current workers for what they have contributed. That is a good prudent fiscally conservative goal. Any pension fund can be so measured according to how close it has come to achieving it.

Some public pension funds are fully funded, others overfunded�yes, overfunded�and others underfunded, the ones that selectively receive all the press attention and ire. I�m still waiting to see a newspaper article about the many public pension funds that are in very good shape despite the recession.

Being underfunded in itself is not a problem so long as enough contributions are coming in to meet current�as opposed to all current and future�obligations. There is no need to reform the balance between revenues and expenses if there is progress toward full funding.

Even if progress is stalled or going in the other direction, there may be no fiscal need for reform if the condition is temporary, as when a recession decreases revenues from pension fund investments�what is currently beleaguering many public as well as private pension funds.

Reforms are only needed for those pension funds whose balances of unfunded liabilities are growing on a long term basis. In the worst of those cases, slight changes in contribution rates deliver dramatic revenue increases. Such abuses as spiking�the artificial driving up of final salaries with overtime and other means to increase benefits�can and should be eliminated. Employer underfunding by skipping contributions that are not made up can be reduced or eliminated. Early retirement incentive programs that offer workers unearned pension credits can be eliminated.

The real aim of the enemies of public pensions, though, is not prudent stewardship of the funds. It is to eliminate them entirely and replace them with 401(k)s.

Public as well as private pension funds can have unfunded liabilities because their benefits are guaranteed. That requires that they be funded properly. Because 401(k)s have no guaranteed benefits, by definition they have no liabilities, funded or unfunded. Their sponsors are thus completely absolved of any responsibility for proper funding.

If a state skips payments to a public pension fund as a means of making up for revenue shortfalls during recessions, that will come back to haunt it in the form of an increased unfunded liability which must be addressed when the economy improves. If an employer skips payments to a 401(k), it can be done without fear of having to face any future reckoning. All future consequences will be borne by workers at retirement.

It is curious that when 401(k)s began in 1981, they were sold on a promise�but with no guarantees�that they would deliver greater benefits than traditional pensions. Now that that claim has been exposed to be false, the argument has shifted to traditional pensions are too expensive. To sustain the new claim, the proponents of 401(k)s have exaggerated the fiscal problems of public pensions�to manufacture the perception of imminent crises where none exist�and attempted to whip up resentment against those who still have secure pension plans.

It is a manufactured crisis that diverts attention from the real crisis: American retirement security is declining rapidly precisely because 401(k)s have increasingly replaced secure, fiscally sound for the most part, traditional pensions.

–James W. Russell

The Simpson-Bowles Attack on Social Security

Despite being stacked with opponents of Social Security, the National Commission on Fiscal Responsibility and Reform�s report, otherwise known as the Simpson-Bowles Report, did not garner enough member votes to be automatically taken up by Congress. The report provides, nevertheless, an indication of the tactics of those who wish to reduce Social Security�s role in national retirement provision and thereby increase the amount of national retirement savings that are funneled through the financial services industry and its 401(k)-like accounts.

Most commentary on the Social Security part of the report centered on its recommendation to raise the normal retirement age from 67 to 69. Far more damaging, though, were its recommendations to reduce benefits by an average 21% and change the formula for determining the distribution of them among income groups.

Social Security Benefits Under Current Law and Reduction Proposed by National Commission on Fiscal Responsibility and Reform


Current Law                             Proposed Law

Income     Benefit      Replacement   Benefit          Replacement

income        %                     income                     %


$  9,000      $  8,100          90%          $  8,100                   90%

$ 38,000     $17,380          46%          $16,800                    44%

$ 64,000     $25,700          40%          $19,400                   30%

$107,000    $32,150           30%          $21,550                  20%


Source: Calculated from The Moment of Truth: Report of the

National Commission on Fiscal Responsibility and Reform,

December, 2010, Figure 11

As the table indicates, the benefit formula would be changed so that middle and upper middle class participants would suffer steeper cuts in benefits than working and lower class ones. The Commission disingenuously touted this as a �progressive� reform.

In fact, it was a change that would have the effect of undermining middle and upper middle class political support for the program, which has been crucial to its success. It is well known that Social Security has survived the attacks of privatizers precisely because it enjoys a cross class base of support.

That attempt to undermine Social Security failed for the moment. But it was immediately followed by another when President Obama with the support of Congress gave a one year reduction of the payroll tax for Social Security from 6.2% to 4.2% for employees. While the money will be replaced by revenue from other parts of the budget, it sets a dangerous precedent as the first such reduction in the history of the program.

A year from now when the reduction expires, Republicans will undoubtedly push to make it permanent, thereby weakening the program�s financing and creating a self-fulfilling prophecy that it is fiscally unsustainable�all as preparation for still another push for privatization.

–James W. Russell

Bad Timing of Investments Harms 401(k)s and Pension Funds

There is an interesting graphic on investment returns in the January 2 New York Times, titled In Investing, It’s When You Start and When You Finish. Thanks to Nat Trumbull for pointing this out to me.

It indicates one of the reasons why 401(k)s have done so poorly. I would argue, though, that even with the best of market timing, they do not perform as well as traditional pensions for retirees.

The graphic also indicates why pension fund investments are doing poorly. Pension funds depend on their rates of contributions, withdrawals (payment of pensions), and investments. The more they depend on investments, the more vulnerable they are to market volatility.

–James W. Russell

Scapegoating Public Employees and Their Pensions

Despite its title, “Public Workers Face Outrage as Budget Crises Grow,” by Michael Powell in the January 1, 2011 New York Times is not a typical public-workers-and-their- pensions bashing piece. It points out that pension fiscal problems have been brought on by states not properly funding them. New Jersey Governor Chris Christie, for example, is refusing to make this year’s required state contribution of $3.1 billion.

These type of pension payment holidays during fiscal crises would be acceptable if they were considered as loans by public employees that need to be paid back during better times. Indeed, public employees could then be seen as heroes who were bailing out state budgets during bad times. But instead they are fodder for self fulfilling prophecies that traditional pensions are not sustainable. No long term pension or retirement savings plan is sustainable if you fail to contribute to it.

The Powell piece provides some balance in its discussion of public employee pensions, including the widespread conservative proposals to replace them with 401(k)s. But it fails to mention the larger context that 401(k)s are sustainable only because they have no guaranteed benefits as do pensions. It also failed to mention that 401(k)s, despite rosy early predictions, have failed to provide adequate retirement incomes. That in turn has created pension envy and resentment that Republicans are playing upon in their scapegoating of public employees.

Unfortunately, the one-sided headline of the article plays into that campaign as indeed have a string of articles and editorials that the Times has been running during the economic crisis. Many readers will just glance at the headline without reading the more more balanced story. The headline will confirm what they think they know, given the dominant media narrative about public employees and their pensions that conservative think tanks have succeeded in implanting.

–James W. Russell

Boomers and Social Security

January 1, 2011

This morning’s New York Times carried a story: “Boomers Hit New Self-Absorption Milestone: Age 65” by Dan Barry that noted that the oldest of the boomers will hit official old age this year. It is a noteworthy demographic fact to comment upon.

If I had been writing the article, I would have made a central theme out of the insecurity of boomer retirement, since their generation—I just missed it by being a late war baby—was massively subjected to having secure traditional pensions replaced by shaky 401(k) stock market investment schemes.

Instead, the only comment Barry made about boomer retirement was in passing:

“About 13 percent of the population today is 65 or older; by 2030, when the last of the baby boomers are 65, that rate will have grown to 18 percent. In addition to testing the sustainability of entitlement programs like Social Security, this wholesale redefinition of old age may also include a pervading sense that life has been what might technically be called a ‘bummer.'”

It is a testament to the success of propaganda campaigns by the opponents of Social Security that journalists like Barry take it for granted that its fiscal sustainability is problematic. Nowhere did he mention that 401(k) were a problematic vehicle for retirement security.

The only danger to Social Security’s sustainability is political not economic: if national politicians do the bidding of the financial services industry and reduce or eliminate its major competitor for retirement savings.

–James W. Russell

The Retirement Crisis and This Blog

The Perfect Swindle is about understanding and finding solutions to the growing retirement crisis facing tens of millions of Americans.

Since 1981 shaky 401(k) schemes that depend on stock market investing have increasingly replaced secure, traditional pensions. The financial services industry encourages the belief that these schemes will produce generous benefits. But 30 years after their first introduction, the first generation to retire under these plans has learned that they produce less than half the benefits of the pensions they replaced.

Even before the stock market crisis of 2008, the signs were everywhere that very few people would be able to accumulate enough wealth through these accounts to ensure financial security. As a result, most people are looking forward to—or rather becoming resigned to—working longer and seeing their standards of living dramatically decline when they do retire.

401(k) benefits are lower than those of traditional pensions because the financial services industry drains considerable management fees, commissions, and profits from the accounts involved; and individual plans lack the advantages of risk pooling that traditional pensions have.

Those who still have traditional pensions, mainly public employees such as school teachers, find themselves under attack for having decent retirement plans. The financial services industry, aided and abetted by conservative think tanks, has mounted a massive propaganda campaign to convince taxpayers with disingenuous scare tactics about unfunded liabilities that their retirement plans should also be converted to 401(k)s.

These same interests would like to further undermine retirement security by privatizing or lowering the benefits of Social Security.

What has and is occurring is a massive swindle in which the financial services industry is raiding the collective retirement savings of tens of millions of people to inflate its profits, which have grown enormously at the expense of retirement security.

This blog is dedicated to exposing and organizing resistance to that swindle.

Who am I? I have researched retirement systems in the United States, Europe and Latin America and written about them in articles and books. The most relevant is Double Standard: Social Policy in Europe and the United States. Through that research I realized how bad the retirement situation is becoming in the United States. I also realized how bad my own retirement situation was since I had a 401(k) like retirement plan. That led to the formation of the Connecticut Committee for Equity in Retirement, a rank and file advocacy group that initiated a union campaign that won the right of public employees in Connecticut to transfer from our failing 401(k) type plan to the state’s traditional pension. We recommend that other employees examine their plans and, if necessary, work toward reforms that will reverse the disastrous trend and restore or create traditional defined-benefit pensions. We are also strong supporters of Social Security, a successful and necessary program that needs to be defended and expanded.

For more information about me, you can go to my website.

This blog will be open to everyone who wants to learn more about the retirement crisis in the United States: accepts its general point of view that defined benefit pensions, including Social Security, are better than 401(k)-type private accounts for ensuring retirement security; and is interested in engaging in progressive retirement reform movements.

–James W. Russell